Electrifying Your Ride

Updated: Jun 9, 2019

Investment summary

The Industrial revolution 4.0, one of the key investment themes for Capstone Global Partners in 2019, has led to a reimagination of the transportation model. In the next 10 years, McKinsey & Co expects the automotive industry to face more disruption than it has seen in the last 50 years. Innovations such as electricity storage and grid digitalization are driving the spread of electrification, starting with transport. Regulatory changes, in response to rising concerns on public health from vehicular emissions, are driving up cost of internal combustion engine (ICE) development. The adoption of electric vehicles (EVs) is on the rise on the back of decreasing cost and increasing consumer acceptance.

Morningstar forecasts EVs will account 15% of new passenger vehicle sales globally by 2028. China and EU will outpace global EV penetration rates at 25% and 20% respectively, while US will lag at 12.5%. Over the next decade, EVs will reach cost parity with ICEs largely due to advancements in battery technology. Massive public charging infrastructure buildout in China and Europe are also set to alleviate range anxiety and EVs should become comparable on a whole product basis to ICEs by 2028. In the US, charging infrastructure will largely be in place along both coasts but sporadic across the rest of the country. Within the automakers, we view Tesla, GM and BMW as the front runners while Geely could be a potential winner in China. Unlike established automakers where investors are arguably paid to wait with strong free cash flow and 4-5% dividend yield, Tesla has yet to prove they can mass produce and faces huge inherent balance sheet, execution and key man risks. Along the value chain, beneficiaries include auto supplier BorgWarner, battery producer Panasonic and lithium producer Albemarble.

Electric vehicles to reach 15% global penetration rate by 2028

Electric vehicles (EV) penetration will likely follow the trajectory of similar innovations that have reached cost parity with prior technologies. These comparables include wind power generation, compact fluorescent lightbulbs, and the first automobiles, all of which share similar characteristics with EVs: functionality held constant, higher purchase (fixed) cost and lower operating (variable) cost, government support, and other considerations. Morningstar forecasts EVs will account for 15% of all new passenger vehicle sales globally by 2028, which appears to be the most bullish among sell-side consensus (ML: 12% by 2025, JPM: 7.7% by 2025, MS: 9%/16% by 2025/30). However, EV penetration rates will vary widely by region. China and the EU will outpace global EV penetration rates at 25% and 20% respectively, while the US will lag the global rate at 12.5%. Hybrid electric vehicles, or HEVs, will account for 21% of all new passenger vehicle sales globally by 2028, making electrified vehicles 36% of total sales. Similar to EVs, HEV penetration rates will vary widely by region. The EU will outpace global HEV penetration rates at 25%, while the US and China will lag the 21% global rate at 20% and 15%, respectively.

Regulation the driving force behind medium-term EV adoption

Over the past few years, regulators have shifted their focus from driving fuel efficiency standards to including electric vehicle mandates. Regions with electric vehicle-specific regulations and incentives will provide a stronger push for EV adoption. The strongest regulatory push will come from governments that specifically help tackle electric vehicles issues and incentivise automakers for producing electric vehicles with better range. Further, regulations that either provide benefits for electric vehicle drivers or restrict ICE drivers will enhance the regulatory push on the consumer side. China will continue to make the strongest regulatory push to increase electric vehicle adoption. The regulations are already having the desired effect as China currently sells the majority of EVs globally. Tightening fuel standards in the EU will push automakers toward electrification over the next decade, while fragmented US policies that vary between states and the federal government will have mixed impact.

Charging infrastructure the path to increased EV adoption

For EV adoption to grow, public charging infrastructure needs to be in place throughout cities and along highways. The lack of public charging infrastructure is the leading cause of range anxiety - as consumers fear being stranded or constrained - and discourages them from purchasing EVs.

Morningstar's estimates that reducing range anxiety will minimally require one charge point per 10km2 and at least two chargers per 10km2 will be needed to relieve range anxiety. Currently, the average in the US, EU, and China is less than three charge points per 100km2. To alleviate range anxiety, China's State-Owned Enterprises (SOEs) are set to build the world's largest EV charging network throughout the country. The State Council's 2020 target aims to build 4.0 million units of charging posts and 12,000 units of charging stations. Regulations that incentivise longer range will spur EV ranges in China to catch-up to EVs in the US and EU. By 2028, EVs are expected to be comparable on a whole product basis to ICEs. The EU will have the second-largest charging network. Public-private partnerships and public grants for charging infrastructure will create a high-speed EV charging network in most parts of Western and Northern Europe. While the infrastructure will be less abundant in Eastern and Southern Europe, it will still be sufficient to reduce range anxiety. By 2028, EVs will be comparable on a whole product basis to ICEs in nearly all of Europe. Range anxiety will disappear in both China and the EU but US charging infrastructure will be fragmented. Along the East Coast, West Coast, and in most major cities, infrastructure will be comparable to the EU, with fast charging networks to be put in place through a combination of public grants, private funding, and utilities to relieve range anxiety. However, it will be sporadic in the rest of the US where range anxiety will continue to limit EV adoption.

How to play the EV theme?

Among the leaders in automakers, we see Tesla, GM and BMW as front runners in electrifying their models and we think Geely could be a potential winner in China. Tesla is well positioned from a product standpoint but has yet to prove their capability in in mass production. Competing automakers do not have cheaper battery platforms yet but are expected to have them by early next decade (potentially GM and BMW in 2021). Geely launched their new energy vehicle strategy in 2015 and aims for 90% of their total sales to come from new energy vehicles by 2020.

Auto suppliers who are positioned to help OEMs meet regulations across multiple powertrains are more likely to increase market share as regulations incentivise sales of EVs, hybrids, and ICE technologies. We see BorgWarner as a beneficiary, especially after acquiring Remy International in 2016, a maker of electric alternators and other electromechanical components.

Lower battery costs will make EVs and hybrids more profitable for automakers and more affordable for consumers. This will drive further demand and benefit auto suppliers. Panasonic is one of the largest suppliers of lithium ion batteries and is the exclusive battery supplier for Tesla.

Regardless of chemistry, all EV batteries will use lithium and solid-state batteries will use even more so lithium producers such as Albemarble will continue to benefit from increasing EV requirements and increased EV and hybrid adoption.